Term Paper
Recent Financial Crisis in East Asian Countries
Experiences and Lessons
Contents
• Pre Crisis Period
• Mexican crisis
• East Asian crisis
• Impact on the economy of the countries
• Role of IMF
• India Position in terms of economic
stability
Pre-Crisis Period
• East Asia had experienced phenomenal
growth in early 1990’s.
• Referred to as the East Asia Miracle.
• Decreased poverty.
• Governments were vital parts of the
economy and privatization was not
reasonable
The Mexican Financial Crisis
• External Factor- Low interest rates in the U.S.
combined with the recession there and in other
countries.
• The inflows in the country was short-term and
aimed at making quick profits through financial
speculation on stocks and other securities in the
financial markets of Mexico
• Gains from the foreign investments were more
illusory than real.
• Mexico was living beyond its means.
Contd..
• Decrease in domestic savings
• Current account deficit.
• During 1990 and 1994, portfolio investment inflow
was $71.2 and 72% of it was used by the Mexican
authorities to finance the current account deficit
Collapse of the peso and later of the economy
 Increased interest rate in USA
 Political agitations in Mexico eroded investor
confidence
 Mexico government announced a 13 percent
peso devaluation which panicked foreign
investors and they started pulling their money out
of Mexico.
 Over the next two days $5 billion fled the country.
The Mexican stock market lost one half of its
value over within months of the devaluation.
Impact of the crisis
• Deterioration of the Mexican economy
• Deterioration of living
• Job loss
• Fall in real wages
• Increased interest rate
• Credit crunch
• Reduction in social sector spending
• The rich have hardly been affected as they
invested their savings in dollars
The Southeast Asian Currency Turmoil
The case of Thailand
• Increased short-term borrowing from international banks and put
greater reliance on portfolio flows rather than on FDI to finance
current account deficits.
• By August 1997 the composition of Thailand’s foreign debt had
become unbalanced.
• Thailand began taking foreign loans in foreign currencies and the
rate of 6-8 percent and started financing domestic companies and
individuals at an interest rate of 14-20 percent in baht.
• Since the opportunities in productive sectors of the economy were
getting reduced largely due to the stagnation in exports, the banks
and financé companies started financing short-term real estate
businesses which was showing boom in early 1990s.
Contd..
• By the end of 1996 and in early 1997 the fall in prices of
real estate had landed the majority of financial firms in
serious trouble.
• In February 1997, Somprasong Land became the first
company to default on a Euro-convertible debenture.
• When it was revealed that around two-third of the
country’s 91 finance companies were in serious trouble,
the investors lost confidence. Both foreign and domestic
investors started buying dollars, taking advantage of the
fixed exchange rates.
• With the FIIs heavy selling in the stock markets, the
share prices dropped to record low levels by 65 percent
in May 1997.
Impact of the Crisis
• The IMF’s conditions include budget expenditure cuts of
about 100 billion baht; increase in the value-added tax
from 7 to 10 percent and further reduction in subsidies
and public investments.
• Many companies have announced cost reduction
measures, which largely include layoffs besides sharp
cuts in wages and benefits
• In rural areas, the small farmers have been affected by
the increased cost of production because price of
agricultural inputs such as chemical fertilizers, seeds,
insecticides, etc. have risen by over 30 percent, while
prices of agricultural produce have not correspondingly
risen.
Contagion Effect on South Korea,
Indonesia, Malaysia and Philippines
South Korea: Victim of Heavy Commercial Borrowings
• The real problem confronting South Koreas was not the
unproductive investments in real estate and other speculative
businesses, but the heavy short-term borrowings by the private
sector financial institutions from foreign commercial banks
• The IMF insistence to increase the interest rates in South Korea has
led to a rise in interest rates at 19-20 percent, nearly 15 percent
above the inflation rate. This move has made more companies
bankrupt.
• With the Korean domestic industry in deep trouble after the stock
market crash coupled with high interest rates and deflationary
pressures, many companies have very little option but to sell their
stakes to foreign investors at throwaway prices.
Indonesia: The Mighty Fall of Rupiah
• Short term investment by foreign players
• In 1997, Indonesian companies had $55 billion
outstanding in foreign debt, 59 percent of which was in
the short-term category.
• The rupiah lost 58 percent of its value against the dollar
in 1997 as Indonesian companies with heavy foreign
borrowings rushed to buy the currency
• The devaluation of the rupiah has led to sharp rise in
inflation thereby increasing the living expenses of the
majority of the population. The shrinking economy had
led to layoffs of thousands of workers.
Malaysia: Failed to avoid the Currency Crisis
• Capital inflows to Malaysia in the mid 1990s were in the
form of short-term loans and portfolio investments.
• Short-term loans supplemented the domestic
investments in the unproductive sectors such as
consumer and property finance.
• Anticipating an oversupply in the real estate business
due to overcapacity and default on short-term
borrowings, the speculative attacks on the ringgit began
which seriously weakened it.
Private Profits, Public Losses: The Great
Asian Bailout Programme
Bailouts for Whom?
• The role of the lenders in the creation of this crisis was
ignored.
• Under the bailout programmes the discipline was
imposed primarily on the debtor.
• The foreign banks alone are given huge subsidies so
that they do not have to suffer for their mistakes, while
local banks and companies were forded to go under.
Who Benefits from Bailout Programmes?
• Trans National Corporations (TNC) operating in the
region suffered short-term losses.
• But in the long run, TNCs have emerged as the net
gainers because labour costs and assets in dollar terms
have sharply declined in the wake of currency
depreciation in these countries.
• To facilitate foreign ownership and takeover of domestic
companies in these countries, the IMF has imposed
conditions which ask for greater accessibility and
ownership rights to foreign companies.
Who Loses?
• Among the major sufferers, the workers are the worst
affected.
• In order to invite foreign capital to buy these public
sector units, the governments had to first shed ‘excess’
workforce.
• These factors have significantly contributed to the
depression of wages and the weakening of the
bargaining power of labour unions.
Washington Consensus
• Growth occurs through liberalization, "freeing up"
markets. Privatization, liberalization, and macro stability
are supposed to create a climate to attract investment,
including from abroad.
• Foreign business brings with it technical expertise and
access to foreign markets, creating new employment
opportunities.
• Foreign companies also have access to sources of
finance, especially important in those developing
countries where local financial institutions are weak.
The IMF and its Contributions to the Crisis
• Capital account liberalization, the removal of restrictions
relating to the flow of capital, in this case, currency.
• The Western world encouraged East Asian countries to
allow foreign investors easier access to the Asian
markets.
• Hot money flowed into the region rapidly but many of
these countries did not have regulations in place to
ensure foreign investment could not be pulled out
without penalty.
• When negative speculation occurred, this money flowed
out of the region as fast as it was initially invested.
Reforms during the crisis
• Increased interest rates, sometimes as high as
25 per cent.
• Decreased government spending. Indonesia's
government had to eliminate food and fuel
subsidies in April 1998.
• Countries had to close poorly performing
domestic banks.
• South Korea had to enact financial reforms and
allow international firms to participate in its
domestic markets.
• Mass layoffs were experienced in many
countries.
• Political reforms
Globalization Discontentedly
• Different countries require different economic
strategies.
• Nations are very interdependent.
• Macroeconomic solutions are needed
Will India go the Southeast Asian Way?
• The financial liberalisation of Indian markets with
heavy reliance on hot money flows will have
serious implications for the financing of current
account deficit.
• Spillover impact of Southeast Asian Currency
Crisis on Indian Rupee
• Hot Money Flows Constitute 80 percent of Forex
Reserves
• Dangers of Capital Account Convertibility
Should India pursue capital account
convertibility?
• Tarapore Committee (1997) defines CAC as "the freedom to convert
local financial assets into foreign financial assets and vice-versa at
market determined rates of exchange".
• It is not immediately possible to give unlimited access to short-term
external borrowings, and
• Full capital account convertibility may encourage arbitrage
operation.
• Voluntary savings in India generated according to the time
preference of the economic agents is mostly sufficient for the gross
domestic investment and growth
• High real rates of interest promotes both financial and total savings
and private sector capital formation by facilitating the accumulation
of finance necessary for undertaking investments.
Conclusion
 Dangers of over reliance on volatile, short-term
capital flows to finance unsustainable current
account deficits.
 These private capital flows are no substitute for
domestic savings
 A country can reduce its exposure to the
volatility of external capital by increasing its
national savings.
 Financial liberalisation policies are less likely to
succeed in the absence of a sound macro-
economic situation